How to trade the Fed opening the door for a March rate cut
Chief Investment Officer
Summary: The fallout from the coronavirus will likely see the Fed downgrading its outlook for growth and waxing dovish on rates, which could see a sharp repricing of expectations for a Fed rate cut already in March. Such a move is far from priced in and could lead to very large moves in short term EuroDollar interest rate futures.
The coronavirus outbreak in China and the major disruptions it has caused will impact the growth outlook with the massive disruptions to travel and basic economic activity – think retail activity and simply the movement of people to and from work, etc.. - across vast swaths of China and as travel to and from China is vastly curtailed until the threat has peaked and ended, a process that could take a few months at best. The Powell Fed is not likely to miss the opportunity to raise concerns on the implications for US growth and especially the inflation outlook from this disruption and could open the door wide for a March rate cut. Eurodollar Futures traders are already pricing higher odds of a cut, but are far from pricing a March move.
Traders looking to trade a more dovish Fed can go long EuroDollar futures (3-month short-term interest rate – strictly speaking this tracks the Libor fixing, but that tracks US 3-month interest rates very closely), as the market has not yet priced in a full 25 basis point rate cut through the June meeting. If the Fed begins cutting again on concerns for the outlook, it could cut in both March and at least once more through the June meeting – actions that are not yet priced in the market. See more on the specific contract and levels below.
Trade: Long the June 2020 EuroDollar contract (GEM0) in 98.40 area, with a stop below 98.30 and a target of 98.75, trailing the stop by 20 ticks once the price exceeds 98.50.
Risk: The risk to this position is that the Fed fails to tilt as dovishly as we expect and sends the message that it would prefer to wait and see for now on interest rates in coming months, leaving to a higher rate expectation from the Fed and leading to a stop-out of the position.
Chart: June 2020 EuroDollar STIR future
Note that this recent rally has broken the late trendline and that if the market is to price a full rate cut and possibly two, the contract could reach new highs as the market prices a 1-1.25% Fed policy rate on the other side of the June meeting (post-June meeting expectations currently at about 1.45% vs. 1.625% currently)
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.